Step up in basis
Key takeaway
A step up in basis generally raises qualifying inherited property’s tax basis to its fair market value at death, although the same rule lowers basis when that value has fallen and special valuation rules and exceptions can apply.
How it works
Basis measures your investment in property for tax purposes. For a sale or other disposition, gain is the amount realized above the adjusted basis applicable to gain, and loss is the adjusted basis applicable to loss above the amount realized. Computing that amount does not establish whether a loss is deductible or whether a special nonrecognition rule applies.
Qualifying property acquired from a decedent includes bequests, inheritances, qualifying revocable trust property and property required to be included in the gross estate.
For federal estate valuation, fair market value is the price at which the property would change hands between a willing buyer and willing seller, neither under compulsion and both reasonably informed about relevant facts. A forced sale price or a price from an inappropriate market does not establish that value, and location must be considered where appropriate.
When alternate valuation applies
An executor’s alternate valuation election covers all property included in the gross estate and must reduce both the gross estate value and the combined estate and applicable generation skipping transfer taxes after credits. Property distributed, sold, exchanged or otherwise disposed of within six months after death is valued on its disposition date. Property retained through that period is generally valued six months after death.
The executor makes the irrevocable election on the estate tax return. No election is available if the return is filed more than one year after its prescribed deadline, including extensions. An interest affected by the mere lapse of time uses its value at death, adjusted for later changes unrelated to that lapse.
Basis records, spouses and special valuation
For inherited property, the initial basis is not necessarily the adjusted basis used on a later sale. Keep accurate records of every item affecting basis, including improvements that increase basis and depreciation or casualty loss deductions that reduce it.
Spousal ownership
For a surviving spouse who is a U.S. citizen, basis in a qualified joint interest combines the survivor’s adjusted cost for their half with the basis of the inherited half. Reduce the survivor’s cost by depreciation and depletion deductions allowed to that spouse. A qualified joint interest means property held by spouses as tenants by the entirety or as joint tenants with right of survivorship where they are the only joint tenants. One half is included in the deceased spouse’s gross estate under the qualified joint interest rule. That rule does not apply when the survivor is not a U.S. citizen.
The survivor’s half of community property is treated as acquired from the decedent if the property is community property under state, possession or foreign law. At least half of the whole community interest must have been includible in the decedent’s gross estate.
For ownership questions, see spousal ownership and inherited basis.
Special valuation limits
When special use valuation has been validly elected for qualifying farm or closely held business real property, inherited basis uses that elected value in place of ordinary fair market value. Review inherited basis values and reporting for special valuation questions.
For land to the extent a qualified conservation easement exclusion applies, the excluded portion retains the decedent’s adjusted basis rather than taking fair market value. Carryover treatment under that rule is limited to the excluded portion.
Points that are easy to confuse
Basis consistency and reporting
For property governed by the inherited basis rule whose inclusion increased federal estate tax liability after credits, basis cannot exceed the final estate tax value. If no final value has been determined and a required basis reporting statement identifies the property’s value, that statement value supplies the ceiling.
For an estate required to file a federal estate tax return under §6018(a), the executor must furnish a statement of reported property values to the IRS and each person acquiring an interest in property included in the gross estate. The deadline is the earlier of 30 days after the return’s due date, including extensions, or 30 days after the return is filed.
The holding period for qualifying inherited property
Property passing from a decedent within the inherited property categories, with basis determined under the inherited basis rules, is treated as held for more than one year if the recipient disposes of it within one year after death. The holding period rule does not itself classify every inherited asset as a capital asset.
Common questions
Does every inherited asset receive a step up in basis?
No, income in respect of a decedent receives no basis step up. Such income was earned but not received by the decedent and was not properly includible on the final return. The estate or person acquiring the right includes it in income in the year received.
For related exceptions and valuation questions, see income tax basis and trust taxation.
Does a gift receive a step up in basis?
A lifetime gift generally carries over the donor’s basis rather than receiving an inherited basis adjustment. If the donor’s basis exceeds fair market value when the gift is made, that fair market value is the basis for figuring loss. A sale price between those two amounts produces neither gain nor loss.
For the two transfer categories, see how tax basis changes with gifts and inheritances.
Can appreciated property given back through an inheritance receive a step up?
No step up applies when appreciated property was given to the decedent during the one year ending at death and passes back to the donor or the donor’s spouse. Appreciated means fair market value exceeded adjusted basis on the gift date. The recipient uses the decedent’s adjusted basis immediately before death. The restriction also applies to sale proceeds the donor is entitled to receive.
Does income tax ownership alone give irrevocable trust assets a basis adjustment at death?
No, retained income tax ownership did not produce a basis adjustment under the IRS ruling’s facts. The grantor made a completed gift of an asset to an irrevocable trust and retained income tax ownership without inclusion in the grantor’s gross estate. The asset appreciated and did not qualify under another inherited property category. At death, trust liabilities did not exceed asset basis, and neither the trust nor the grantor held a note on which the other was obligor. Under those facts, basis immediately after death equaled basis immediately before death.
The ruling does not establish a universal rule denying adjustments to property outside a gross estate. Qualifying bequests, devises, inheritances and other specifically described inherited property can receive an adjustment. Read more about irrevocable trusts and basis at death.